NECESSITY,
FUNCTION, AND CONFORMITY: KRS 131.130(1) authorizes the Department of Revenue
to promulgate administrative regulations necessary for the administration and enforcement
of all tax laws in Kentucky. This administrative regulation establishes the
sales and use tax requirements for transactions relating to the oil and gas
extraction industry.

Section
1. Definition. "Contract driller" means a person performing a
drilling service for the owner or operator of an oil or gas well under a contractual
relationship for consideration.

Section
2. Eligible Property for Exemption. The storage, use or other consumption of
tangible personal property for use in the extraction or production process for
oil or natural gas which will be for sale shall be exempt from the sales and
use tax according to the provisions of KRS 139.010, 139.470(10), and 103 KAR
30:120.

(1)
The extraction or production process for oil shall be considered as beginning with
the erection of the drilling rig at the drilling location and shall be
considered as terminating at the settling tank immediately prior to
transportation. Oil tanks used for storage alone shall be subject to tax.

(2)
The extraction or production process for natural gas shall be considered as
beginning with the erection of the drilling rig at the location of the well and
shall be considered as continuing until the gas leaves the outlet on the
discharge side of the final gathering compressor station. The pipeline from the
outlet to the transmission line shall be subject to tax.

(3)
The list in this subsection shall serve as examples of machinery used in the
extraction or production process:

(a)
Drilling rigs;

(b)
Casings;

(c)
Tubing;

(d)
Well head equipment;

(e)
Pumps;

(f)
Compressors;

(g)
Production and gathering pipe;

(h)
Cleaning equipment; and

(i)
Oil settling tanks.

(4)
The list in this subsection shall serve as examples of other tangible personal
property used in the extraction or production process:

(a)
Drilling bits;

(b)
Explosives;

(c)
Drilling muds; and

(d)
Chemicals.

(5)
Tangible personal property shall not be exempt from sales and use tax if it is
used as "repair, replacement, or spare parts" as defined in KRS
139.010(26).

Section
3. Extraction or production process shall include the following operations:

(1)
Drilling and equipping wells, to include:

(a)
Drilling of the hole by the drilling rig to the producing formation;

(b)
Installing casing and tubing in the hole;

(c)
Stimulating production by explosives or other means; and

(d)
Completion of the well by the installation of machinery and equipment; and

(2)
Pumping, gathering, and cleaning.

(a)
Pumping shall include the use of separate pumps on individual wells, group well
pumps, and auxiliary pumps at other points on the gathering system. The
machinery and appurtenant equipment used in secondary methods of recovery
including gas repressuring or water-flooding shall be considered part of the
extraction or production process.

(b)
The gathering system shall consist of a series of pipelines connecting several
different wells with settling tanks grouped together for production purposes. Compressors
used to stimulate production and to continue in effect the processing
production operation shall be considered part of the gathering system.

(c)
Cleaning operations shall occur in the final settling tank where impurities are
removed from oil by chemical heating and settling processes. If a well produces
both oil and gas, separator equipment shall be necessary at appropriate points
in the gathering lines to separate the oil and gas. In addition, various types
of machinery may be used at different points in the gathering system to clean
oil or gas.

Section
4. Nonproduction Process. Preliminary work, transportation, and marketing shall
not be considered part of the oil or gas extraction or production process.

(1)
Preliminary work shall include:

(a)
Geological and geophysical work;

(b)
Leasing or purchasing operations;

(c)
Determination of drilling sites; and

(d)
Surface work preparatory to drilling.

(2)
The transportation of oil shall be considered as commencing when the oil is
pumped from the settling tank into transportation facilities, which may be
truck, rail, or pipeline, or a combination thereof.

(3)
The transportation of natural gas shall be considered as commencing at the
point where the production or gathering system ceases, and it is delivered into
pipelines for transportation to the retail distribution system.

(4)
The marketing of natural gas shall be considered as commencing when the
pressure in the transportation line is reduced and the gas is delivered into a
low-pressure system for distribution to the ultimate retail consumer.

Section
5. Contract Drillers. (1) The exemptions provided in KRS 139.470(10) and
139.480(10) shall not apply to purchases made by a contract driller as a
contract driller is providing a service and is the consumer of the machinery
and materials used to provide the service.

(2)
A contractor may execute a "Certificate of Exemption Machinery for New and
Expanded Industry", Form 51A111, which is incorporated by reference in 103
KAR 3:020, jointly with an oil or gas well owner or operator to purchase machinery
only if the real or ultimate ownership of the machinery lies with the owner or
operator.